Demand-Pull and Cost-Push Inflation

Inflation can occur for several reasons, and economists usually distinguish between two basic types of inflation, depending on whether it originates from the buyers’ or the sellers’ side of the market.

Perhaps the most familiar type of inflation is called demand-pull inflation, which is a rise in the general price level resulting from an excess of total spending (demand). Demand-pull inflation occurs when aggregate demand in the economy increases faster than the economy’s productive capacity. If demand exceeds aggregate supply, the average prices of goods and services are pulled up by the “excess” demand. Demand-pull inflation is often expressed as “too much money chasing too few goods.” When sellers are unable to supply all the goods and services buyers demand, sellers respond by raising prices. In short, the general price level in the economy is “pulled up” by the pressure from buyers’ total expenditures.

This type of inflation is usually associated with conditions of full employment. If there are unemployed resources available, an increase in demand can be met by bringing these resources into employment. Supply will increase and the increase in demand will have little or no effect on the general price level. If the total demand for goods and services continues to increase, a full employment situation will eventually be reached and no further increase in output is possible at least in the short run. Once the nation’s resources are fully employed, an increase in demand must lead to an upward movement of prices.

A situation of excess demand may also arise when a country is trying to achieve an export surplus, in order, perhaps, to pay off some overseas debts. Exports are inflationary because they generate income at home but reduce home supplies.

Besides, demand-pull inflation may develop when, with full employment, a country tries to increase its rate of economic growth.

Another possible cause of inflation under conditions of full employment is an expansion of government spending financed by borrowing from the banking system.

Cost-push inflation is an increase in the general price level resulting from an increase in the cost of production. Most sellers try to push these higher costs on into higher prices even if there is no change in aggregate demand in the economy.

One source of cost-push inflation is supply shocks, such as widespread and severe crop failures, the sharp increases in the price of oil instituted by a cartel, etc. The effect of a supply shock is to raise the level of input prices above the level that firms had expected.

Another possible source of cost-push inflation is the momentum of inflationary expectations generated by previous demand-pull inflation. The influence of expectations on both demand-pull and cost-push inflation is an important consideration.

Ex. 1. Match the following Russian word combinations with their English equivalents.

A

B

инфляция, вызванная превышением спроса над предложением (инфляция спроса) инфляция, обусловленная ростом издержек (инфляция издержек) избыток совокупных расходов инфляционные ожидания рост цен совокупные расходы шоки предложения расширение расходов правительства общий уровень цен избыточный спрос производственная мощность экономики активный торговый баланс (превышение стоимости экспорта над стоимостью импорта)

an excess of total spending total expenditures the general price level the “excess” demand an expansion of government spending supply shocks a rise in prices demand-pull inflation cost-push inflation inflationary expectations export surplus economy’s productive capacity

Ex. 2. Express in one word:

1. to take place, to happen;

2. amount beyond what is needed;

3. looking forward to smth.;

4. to obtain by money;

5. that which someone owes;

6. ready or present for immediate use;

7. a group of separate business firms which work together to increase profits by not competing with each other.

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Words for reference: surplus, anticipation, debt, available, cartel, occur, purchase.

Ex. 3. Choose the correct answer.

1. Demand-pull inflation is caused by:

1. monopoly power;

2. energy cost increases;

3. tax increases;

4. full employment.

2. Demand-pull inflation occurs:

1. when ‘too much money is chasing too many goods’;

2. during a recession;

3. rising production costs;

4. none of the above.

3. Cost-push inflation is due to:

1. excess total spending;

2. too much money chasing too few goods;

3. resource cost increases;

4. the economy operating at full employment.

Ex. 4. Say whether the following is true or false.

1. Demand-pull inflation occurs when aggregate demand in the economy increases faster than the economy’s productive capacity.

2. Demand-pull inflationary pressure increases as the economy approaches full employment.

3. Expansion of government spending financed by borrowing from the banking system results in cost push type of inflation.

4. Cost-push inflation is caused by too much money chasing for few goods.

5. Expectations do not have any influence on demand-pull inflation.

Ex. 5. Expand the sentences.

1. The text deals with … .

2. Demand-pull inflation is associated … .

3. An excessive demand is usually caused by a) … b) … c) … and d) … .

4. Cost-push inflation occurs when … .

5. The possible sources of cost-push inflation are … .

6. Supply shocks are caused by … .

7. Another possible source of cost-push inflation is … .

Text 3

Read the text and do the tasks that follow.